Better Know a Marijuana Stock: Arena Pharmaceuticals — The …

Few industries are growing as rapidly as the legal marijuana industry, and marijuana stock investors are certainly beginning to take note.

According to investment firm Cowen Co., the U.S. legal marijuana market has the potential to reach $50 billion in sales by 2026. Comparatively, per Marijuana Business Daily's new report, "Marijuana Business Factbook 2017," legal U.S. sales are only expected to total $5.1 billion to $6.1 billion this year. This suggests that there's a massive long-term opportunity for marijuana businesses to lure black market customers over to the legal side of the equation. This trend is what's sent a majority of marijuana stocks higher by a triple-digit percentage over the trailing year.

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But choosing a marijuana stock to invest in could be extremely difficult since there are dozens of them. Emotions surrounding the pot industry are running high, but worst of all, investors could be blindly buying into marijuana stocks without fully understanding the risks involved.

With this in mind, we're taking the time to analyze a new weed stock each week until we've covered all of the larger players with market caps in excess of $200 million. Here are the marijuana stocks we've discussed so far:

Today, we're going to take a closer look at Arena Pharmaceuticals(NASDAQ:ARNA).

What Arena Pharmaceuticals does

Unlike GW Pharmaceuticals and Zynerba Pharmaceuticals, which rely on cannabinoid-based medicines to fill out the entirety of their drug-development pipelines, Arena Pharmaceuticals is one of the drug developers like Insys Therapeutics and Cara Therapeutics that have some of their pipelines devoted to cannabinoid-type therapeutics or CB agonists and other portions devoted to non-cannabinoid medicines.

Arena Pharmaceuticals' pipeline currently consists of three clinical-stage therapies and a small handful of partnered programs. Etrasimod, an S1P receptor modulator, and ralinepag, a prostacyclin receptor agonist, have nothing to do with cannabinoids and are the furthest along in clinical studies, while APD371, a CB2 agonist, is also in clinical-stage studies. APD371 is where Arena gets its "marijuana stock" moniker, which will be described in more detail below.

Arena is also the company behind the Food and Drug Administration-approved weight-loss drug Belviq, which it sold to its marketing partner Eisai(NASDAQOTH:ESALY) for $23 million in January.

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Promise and opportunities

Arguably one of the most exciting developments from Arena this year was its sales of Belviq to Eisai. Belviq has been a chronic underperformer, and the disposition of the drug not only provided Arena with $23 million in cash, it could reduce its collaborative obligations with Eisai by up to $80 million. For a company that's currently losing money, that's a pretty big financial swing.

At the same time, dumping Belviq allows Arena Pharmaceuticals to focus on its trio of clinical-stage products. Two years ago, Arena reported positive phase 1b results involving etrasimod for the treatment of various autoimmune diseases, including ulcerative colitis, which is currently in phase 2 studies. The early stage study demonstrated up to a 69% dose-dependent lowering in lymphocyte count from baseline, which returned to normal within one week after the conclusion of dosing. The press release suggested that this early data was consistent with the efficacy shown in successful phase 2 and 3 studies involving S1P1 modulators in multiple sclerosis, psoriasis, and ulcerative colitis. In other words, etrasimod, though still in early trials, looks promising.

Of course, the real buzz involves APD371, which is an oral Crohn's disease pain drug that targets the CB2 receptor of the naturally occurring cannabinoid receptor system in our bodies. Targeting CB2 is a smart move for Arena (and other drugmakers, for that matter) since the CB2 receptor has been shown to provide pain relief without the normal psychoactive effects observed with targeting the CB1 receptor. Its primary goal is to replace opioids, which can be addictive and even deadly. Some 20,000 people in the U.S. died from prescription opioid-related overdoses in 2015, compared to zero marijuana-based overdose deaths.

A placebo-controlled phase 1b dose-escalating study involving APD371 appeared safe, with only low-grade adverse events observed. Furthermore, all doses tested, even lower doses, were deemed to be more than enough to stimulate the CB2 receptor and achieve the desired biologic effect. Replacing opioid therapies is a lofty goal, but it's Arena's biggest hope.

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Risks and concerns

Of course, no marijuana stock is perfect, and Arena Pharmaceuticals has a number of potential flaws.

Perhaps the biggest issue the company is contending with is its ongoing quarterly losses and declining cash on hand. Although the company ended the first quarter with $79.5 million in cash and cash equivalents, and it scored an additional $75.5 million in net proceeds from selling 70 million shares of common stock in April, Arena's only means to raise cash of late has been selling assets or diluting its existing shareholders. If the company's $22.5 million net loss in Q1 is any indication, Arena is on track to burn through around $90 million in cash this year. With recurring revenue still likely years away, cash concerns remain front and center.

Management is yet another concern for Arena. For instance, the approval of Belviq back in 2012 was supposed to pave the way for a potential blockbuster drug. Instead, Belviq sales struggled to get off the ground. This failure to launch, even with a commercialization partner, weighs on Arena and could call into question its ability to effectively launch new products.

There's even concern about APD371 given that it has very limited efficacy data thus far, and would be entering a space with a veritable sea of competition. Opioid drugmakers aren't going to go down to CB2-targeting therapies without a fight, and upending incumbent therapies in treating pain associated with Crohn's disease could prove difficult.

In other words, Arena still has a lot to show investors with regard to pipeline efficacy before its current valuation can even be merited.

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Should you buy Arena Pharmaceuticals?

Now for the most important question of all: Should you buy Arena Pharmaceuticals?

On one hand, the promise of an opioid-replacement therapy for certain types of pain could yield big money for Arena and major profits for its shareholders. Opioid addiction is a clear problem in America, and providing a potentially safer alternative for pain relief, assuming it's just as effective as opioids, would be optimal. With roughly 1 in 8 Crohn's disease patients with associated pain receiving prescription opioids, Arena's market potential would appear to be quite large. Tack on added pipeline diversity with anti-inflammatory and rare-disease therapies in development, and there are certainly reasons for Arena to possibly head higher.

On the other hand, Arena is losing money hand-over-fist, and that doesn't look to change anytime soon. We've also seen very little in the way of human clinical efficacy, but within the next couple of quarters we should have a lot of data to stew over.

My suggestion for investors would be to remain firmly on the sidelines until we have a clearer look at the efficacy and safety of Arena's experimental drugs.